In his semi-annual address to Congress begun this morning, Federal Reserve Bank Chairman Benjamin Bernanke opposed the set of forced spending cuts set to go into effect on March 1st. Bernanke sees the $85 billion in undesirably directed spending cuts notoriously known today as the Sequester as an obstacle to economic growth.
In his prepared presentation this morning, Chairman Bernanke said the spending cuts Congress has put in place will work against the economy this year. He said there would be an estimated 1.5% impact to GDP growth caused by austerity-like spending cuts. Bernanke indicated that sequestration alone would work against economic growth by an estimated 0.6%. Mr. Bernanke, of course, agrees that the national debt must be tamed and the budget must be mastered, but he would apply a more measured method in doing so.
Considering the degree of effort and creativity the Fed has put into keeping the economy afloat and growing, this has got to be frustrating to the Fed Chief. The Fed went over and beyond during the first days of the financial crisis. Chairman Bernanke was leaned on heavily for direction through the crisis, and at times was clearly considered by everyone to be the smartest mind in the room. It would not be a reach to say that during the crisis, he held more power than the President because of how reliant the government was on his direction.
Over recent years, the Fed Chairman and the Bank have taken some heat over what the future effects of its long-term low-rate policy and its unorthodox creation of synthetic demand in asset-backed markets might be. Yet without those efforts, we would likely be years behind our current pace in the housing market recovery. The five-year chart of the SPDR S&P Homebuilders (XHB) security reflects the gains in housing, which are largely attributable to the Fed's direct efforts.
Likewise, housing sensitive and highly cyclical and integral industries like banking would likely be farther behind today than they have come. Bank of America (BAC) is a good representative of the gains aided by the Federal Reserve's efforts to date. BofA and peers Citigroup (C), J.P. Morgan Chase (JPM) and others owe their existence today to the "bailouts" led by the Treasury Department, which were certainly supported by the Fed Chief. Yet, even with those efforts, only recently have the banks really started to grow again. That's how bad things got, in case you have forgotten. Without the finance industry, our small businesses would be hampered, and the consumer sector stymied as well. In such an environment, I doubt we would have gains like we have seen in the SPDR S&P 500 (SPY), SPDR Dow Jones Industrials (DIA) or the PowerShares QQQ (QQQ), or in other words stocks, over the last few years. Furthermore, the future would be bleak without question; at least today there is a question about it.
If the Sequester happens, the defense sector will certainly be affected, since half of the cuts are directed at Pentagon spending. Thus, the latest declines are explained in the shares of Honeywell (HON) and General Dynamics (GD), to name two. Since there is a decent chance that this time the government might allow the issue to pass without mitigation, versus the debt ceiling and fiscal cliff midnight-hour deals, it makes sense to steer clear of defense for awhile. As for stocks, generally speaking, capital flows have been favorable into equity funds, and seem to offer some support to a floor for equities.
Our entire financial system and perhaps our civilized state owe a great deal to the direction of the Fed through those tested times not long passed. So, the Fed Chief's opinion today, when lower economic impetus allows our leaders a more comfortable degree of decision-making, is discounted. It's unfortunate, which is something even I can say, as I hold an opinion of high concern about future inflation and fiat currency valuation. Where I disagree with the Fed is in an area beyond its and my control. I believe a higher degree of cutting could be accomplished today if it were rightly directed and thereby unimpeded by political positioning. Since it is not, the Fed Chief may once again be the wisest voice in the room.
Bernanke says a slower recovery burdened by sequestration and austerity-like cuts would lead to less deficit reduction near term. Bernanke suggests replacing sequestration with policies that reduce spending less dramatically in the near term, though more substantially over the long term, would be wiser. Perhaps rather than pushing our national defense to destructive direction, we might listen to the wise man one more time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.